Shell and No-Risk Oil

It's feeling euphoric in the oil sector these days.

Valuations for E&Ps are good. And firms are having no trouble raising capital.

There's been a spate of junior financings in the hundreds of millions of dollars range. And last week even the majors got in on the action, with Shell issuing $3.75 billion in bonds and debentures.

The really interesting thing was the rate on Shell's new debt. The company's 5-year notes were sold at just 55 basis points (0.55%) above Treasuries. Even Shell's longer-dated, 10-year notes only commanded 83 basis points to Treasuries.

That means investors are demanding much less than 1% in extra return in order to tie up their money for 10 years with an oil company, rather than the U.S. government.

It might be tempting to blame this low premium on mistrust of government bonds. But the mood lately in the petroleum sector suggests that investors just don't see a lot of risk here. And are thus happy to put in money at lower returns.

This is striking for an industry that's often taken to task for its potential downsides. There's the political problems (which Shell's globalized portfolio is probably somewhat insulated against--although recent events in Nigeria might suggest otherwise). And possible swings in commodity prices (which Shell has absolutely no control over). To name a few.

And yet Shell's new investors have largely overlooked these factors. The commodity price risk being particularly surprising, given oil is trading at quite-elevated levels, raising the possibility of a pullback.

But investors today want a story to believe in. There's been so little good news around global stock markets. And one of the only bright spots has been the phenomenal success and wealth creation of the North American unconventional oil and gas sector.

Investors in U.S. E&Ps have done very well. And the giddy feeling has spilled over into the wider energy sector. If Bakken producers are good, all oil producers must be too.

The psychology is understandable. But the effects could be dangerous for investors putting money into the sector at higher valuations, and thus higher risk of losses.

Choose your spots wisely.

Here's to a good story,

By. Dave Forest